Education Planning Part II: Saving Plans, Repayment, & Student Loan Forgiveness
August 22, 2023
In our last blog, we talked about whether it still makes sense to attend college given the rising cost of tuition. If your kiddo is college-bound or you’re simply planning ahead (kudos), here are some important things to know about saving for your child’s education and helping them manage student loan debt wisely.
Save Early, Save Often
The key to offsetting the rising cost of higher education is to start saving as early as you can. Just like with any monetary investment, time is your secret weapon. The longer you give your money to compound, the more your savings will grow.
Say you contribute $500 a month to a 529 plan for 18 years that earns five percent interest each year. By the time your child turns 18, the account will be worth $168,794 (your $108,000 in contributions plus $60,794 in interest), thanks to compounding interest.
But say you wait until your child is 12 before you start saving. Under the same circumstances, you’d have $40,811.48—your $36,000 in contributions and only $4,811 in interest.
Of course, better late than never, but the more time you give your money to grow, the harder it’ll work for you.
There are several options when it comes to the savings and investment vehicles you use. The most common is a 529 plan, which is state-sponsored and can be used to cover a variety of qualifying educational expenses. If your child ends up not needing the money you saved for education (maybe they got a full ride somewhere or decided to join the workforce after graduating high school), there are several things you can do with those funds:
- Take the Money Out: You can always cash in your child’s college savings account if they don’t use it. But it’s important to know that you’ll probably have to pay taxes and penalties on the earnings, although the money you invested is returned to you with no tax implications.
- Change Beneficiaries: You can also change your beneficiary. For example, if you have two children and your firstborn decides not to attend college, you can then update the beneficiary and save the funds for your other child. You can also hold the money in the account indefinitely and save it for your grandkids or even great-grandchildren.
- Use the Money Yourself: Another option is to use the funds for your own educational endeavors. Maybe you’ve always wanted to learn Italian, and there are courses offered at a nearby college, or you want to get your master’s degree—you can make yourself the beneficiary and use the funds to cover expenses at any accredited institution.
Some other options would be a Coverdell education savings account or a Uniform Gift to Minors Act (UGMA) custodial account that names your child as the beneficiary.
There are pros and cons to each kind of savings plan, and the best option will vary from family to family. If you need help determining which route is best for yours, we’d be happy to discuss it with you.
How to Pay Off Student Loan Debt
Once your child graduates, student loan lenders will soon come knocking (typically within six months of finishing school). And the sooner your child can pay off those student loan debts, the better. Not only will they pay less in interest over time, but getting those payments off their balance sheet will allow them to more effectively pursue other goals, like buying a home, starting a family, and getting ahead with their retirement savings.
As a best practice, we recommend devoting 8 to 20 percent of one’s take-home pay to paying off student loans. If it’s doable, plan to pay them off within three or four years—and if that’s not possible, shoot for five to ten years. (This is incredibly important to think about when considering which college your child can afford—because the more they delay payments, the more the interest will inflate, and the longer they’ll have to delay other financial goals.)
Sometimes, though, paying off student loan debt in 10 years or less just isn’t feasible. If that’s the case, your child might consider an income-driven repayment plan. But again, while these options (some of which allow you to extend the payment over decades with low minimum payments) might seem attractive, they don’t eliminate the issue of inflated interest, and your child could end up paying much more over time than they would if they chose their school based on what they could reasonably afford.
But Wait, Won’t Their Student Loans Just Be Forgiven?
Yes, there has been a lot of talk in the news lately about student loan forgiveness, but so far, no legislation has passed. That’s not to say the day will never come when federal student loan debt is forgiven, but it’s not wise to plan for the future based on the assumption that it will be.
Even if your child’s (or your) student loan debt is forgiven, it’s possible that they could be on the hook for a large tax bill based on the amount forgiven.
To get the best ROI for your child’s education, you need to plan early and strategically. If you’d like help preparing for education costs, we’d love to chat with you. Schedule a consultation with us or give us a call.